Magazine article The CPA Journal

AUD | Searching for Buried Treasure: The Elusive Completeness Assertion for Revenue, Part 2

Magazine article The CPA Journal

AUD | Searching for Buried Treasure: The Elusive Completeness Assertion for Revenue, Part 2

Article excerpt

Last month, this column discussed identifying and addressing risks of material revenue understatements in general, and those specific risks presented by outsiders who control and have an incentive to intentionally-or sometimes unintentionally-underreport the transactions or activities that generate revenues that are based on contractual requirements with others, such as customers, lessees, or licensees. This column continues by discussing l) special risks associated with the use of managing agents who are entrusted with, among other functions, the collection of and accountability for revenues, and 2) risks associated with fraudulent behavior by management (such as that motivated to minimize income taxes) or against the company (such as employee theft, commonly motivated by economic stress).

Special Risks Associated with Managing Agents

Whenever an entity operates, in fact or substance, as a central management company or managing agent of properties owned by others that are or include properties or other operations both within and outside the entity or group of entities currently under audit, a principal risk, especially when properties are being sold, is that the operating results might be overstated or understated. This generally occurs through intentional or inadvertent misdirection of revenues or expenses from or to properties outside the group of controlled properties, such as by misallocations of general and administrative or other common costs and expenses. It is also necessary to ascertain and consider whether a significant risk of misstatement is posed by incentive compensation arrangements with various principals of the managing agent that might cause it to want to shift revenues or profits from one property or entity to another.

Accordingly, auditors must be concerned with, and probably test, controls over the maintenance and protection from alteration of signed leases and the receipt, recording, and transmission of rent and other revenues by the managing agent, particularly when cash might be involved. Based on the perceived strength or weakness of relevant controls, auditors ordinarily should, at a minimum, perform substantive analytical procedures comparing key operating ratios of the controlled properties to those of others outside the group, cautiously considering that what look like relatively small percentage variances could, in fact, translate into large dollar amounts requiring further investigation.

As noted last month, however, auditors must be mindful that analytical procedures may not be sufficiently precise to stand alone regarding any assertion with a perceived significant risk of material misstatement, unless adequately supported by relevant control testing at the managing agent level (as noted in last month's column). Such testing should be designed to assure, among other things, that revenue is being credited to the appropriate property. Substantive tests of revenue completeness, particularly when reported occupancy is low or merely below expectations, ordinarily should include onsite property inspections that focus on whether the apparent occupancy is consistent with the reported or expected revenue level. Such inspections also may contribute to other audit objectives unrelated to revenue, such as asset impairment tests.

Completeness of Revenue Risk in Periods of Economic Stress

Fraud often occurs as a result of some combination of incentive (motivation), opportunity, and rationalization. …

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